The Impact of Inflation Targeting: Testing the Good Luck Hypothesis

Federico Ravenna

Cahiers de recherche from CIRPEE

Abstract: Over the last twenty years the level and volatility of inflation decreased across industrial countries. The inflation stabilization can be explained by a shift in monetary policy or by a lucky period of low volatility in business cycle shocks. To test the “luck hypothesis” we examine the inflation experience of Canada, one of the earliest and most successful adopters of an inflation targeting monetary policy. We Kalman-filter the historical structural shocks consistent with an estimated DSGE model. The estimated shocks are used to build counterfactual histories. Ex-ante the model predicts inflation volatility to more than halve under inflation targeting. But conditional on the shocks, we show that the luck hypothesis can explain with a high probability Canada’s low inflation volatility since the early 1990s. Any inflation stabilization induced by the shift in policy is accounted for the most part by the impact on expectations. Counterfactuals built neglecting expectations would prove the inflation targeting policy irrelevant.

Keywords: Business cycle shocks; Kalman filter; Credibility; Inflation targeting (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mic and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Journal Article: The impact of inflation targeting: Testing the good luck hypothesis (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:lvl:lacicr:1029

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